Part 1

Overview

Role and functions

The AOFM, a 'prescribed' agency under the Financial Management and
Accountability Act 1997, was established within the Treasury portfolio
to assume responsibility for the Commonwealth's debt management activities
previously undertaken within the Treasury. The AOFM commenced operations
on 1 July 1999.

The AOFM is responsible for advising the Treasurer, the responsible
Minister, on all aspects of Commonwealth debt management. In addition,
the Treasurer has provided delegated authority to AOFM officials in
relation to certain powers under the legislation governing Commonwealth
debt management, to enable them to exercise those powers on his behalf.

The principal objective of the AOFM is for Commonwealth debt to be
raised, managed and retired at the lowest possible long-term cost, consistent
with an acceptable degree of risk exposure.

Debt management operations cover the issue of various borrowing instruments,
the strategic formulation and undertaking of portfolio management, including
through swap transactions, the administration of the redemption of debt
represented by CGS, including that on issue for the States and Territories,
and the assessment of the budgetary cost of the Commonwealth's net debt
portfolio.

Figure 1: Organisational structure

* Ted Evans stepped down from his position as Secretary to the Treasury
on 26 April, 2001. Dr Ken Henry commenced his appointment as Secretary
to the Treasury on 27 April, 2001.

Outcome and output information

To enhance the Commonwealth's capacity to manage its net debt portfolio,
offering the prospect of savings in debt servicing costs and an improvement
in the net worth of the Commonwealth over time.

The AOFM has one output - debt management. This was formerly reported
under the program structure as subprogram 1.6 of the Treasury.

Figure 2: Outcome and output structure

In common with most entities with significant financial exposures in
their balance sheet, the Commonwealth has been moving increasingly in
recent years to conduct its debt management activities within an explicit
risk management framework. In conducting its portfolio management and
debt issuance activities, key risks managed by the Commonwealth include
funding risk, market risk and credit risk. A description of the management
of these risks is provided below in the context of the 2000-01 outcomes.

Table 1: Resources for AOFM outcomes

Budget
2000-01

Actual
2000-01

Budget
2001-02

($'000)

($'000)

($'000)

ADMINISTERED

Expenses against administered appropriations

Annual appropriations

4,429

1,591

4,082

Special appropriations

8,675,525

10,561,198

7,172,940

Total administered expenses

8,679,954

10,562,789

7,177,022

Capital and other administered appropriations

Annual appropriations

3,400

-

3,400

Special appropriations

52,227,522

23,115,740

35,674,584

Total capital and other administered
appropriations

52,230,922

23,115,740

35,677,984

Total administered resourcing

60,910,876

33,678,529

42,855,006

AGENCY

Output 1.1 - Debt management

5,706

5,706

5,822

Total revenue from government (appropriations)
contributing to price of agency outputs

5,706
97.2%

5,706
97.8%

5,822
99.7%

Revenue from other sources

Output 1.1 - Debt management

162

126

20

Total revenue from other sources

162

126

20

Total price of agency outputs

5,868

5,832

5,842

Capital agency appropriations

Loans

749

-

-

Total capital agency appropriations

749

-

-

Total agency resourcing

6,617

5,832

5,842

Total resourcing for outcome 1

60,917,493

33,684,361

42,860,848

Budget
2000-01

Actual
2000-01

Budget
2001-02

Average staffing level (number)

42

23

40

Performance information

Performance indicators for the outcome include:

- achievement of the Commonwealth's financing task in a cost-effective
manner;

- efficient execution of the Commonwealth's borrowing activities. Partial
positive indicators include the narrowness of the range of accepted
bids and of the basis point spread between tender and secondary market
yields;

- efficient management of the Commonwealth's cash balances. Indicators
include achievement of the Ministerially endorsed cumulative average
cash balance target as at end-year; and

- timely production of reports on debt management activities.

2000-01 outputs

Cost-effective financing

Despite the continuation of a surplus funding position in 2000-01,
as in recent years the AOFM has undertaken modest issuance programs
directed at maintaining net debt within agreed portfolio limits as well
as seeking to maintain the liquidity and efficiency of CGS markets.
In addition, maintenance of an efficient, liquid Commonwealth yield
curve assists the continued growth and development of a range of domestic
derivative and related markets and is consistent with the Government's
commitment to the further development of Australia as a centre for global
financial services.

As noted above, the Commonwealth's debt management activities are conducted
within an explicit risk management framework, with one of the key risks
for management being funding risk - the risk that an issuer is unable
to raise funds, as required, in an orderly and cost-effective manner.
Cost-effective debt issuance requires appropriate stock selection, efficient
execution of transactions, the maintenance of a diverse investor base,
deep liquid markets, and an efficient yield curve for CGS.

To this end, the practice of concentrating
debt issuance into liquid benchmark stocks continued in 2000-01. Treasury
Fixed Coupon Bond issuance in 2000-01 focussed on building up the volume
on issue of the May 2013 stock. Extensive liaison with financial
market participants was maintained over the year in order to assess
market conditions and guide issuance decisions.

Borrowing activities

Treasury Fixed Coupon Bonds are the main debt instrument issued by
the Commonwealth. An aggregate $2.3 billion (face value) of Treasury
Fixed Coupon Bonds were issued in 2000-01, the program being conducted
over five tenders. The average range of tender bids accepted was 1.6
basis points and the average margin between the weighted average yields
achieved at tender and the prevailing secondary market mid-rate was
around half of one basis point.

Treasury Indexed Bonds were the other medium to long term debt instrument
issued, with an aggregate $300 million (face value) being issued in
four tenders. The average range of accepted bids was 4 basis points
(narrower than in 1999-2000). The margin between yields accepted at
tender and the prevailing secondary market mid-rate yields, while variable,
averaged less than one basis point.

Cash management

The Commonwealth's short term debt instrument, Treasury Notes, are
issued to finance the within-year timing mismatch between the payment
of Commonwealth Government outlays and the receipt of Commonwealth Government
revenues. Twenty-four Treasury Note tenders were conducted with issuance
being around $14.4 billion (face value). The average range of accepted
yields on the stock offered was 2.3 basis points. The Treasury Note
tender program was managed such that, over the course of the full year,
cumulative average cash balances were within the ministerially prescribed
target.

Portfolio management

The reduction in Commonwealth debt as a result of ongoing fiscal consolidation
has been managed by reference to an explicit policy framework governing
acceptable market risk exposures at the portfolio level. Market exposures
arise from the potential for changes in financial prices, such as interest
and exchange rates, to affect the ongoing economic cost and market value
of the Commonwealth portfolio.

Market risk is managed by reference to a tightly defined portfolio
benchmark that serves as a target for the composition and nature of
market risks within the Commonwealth portfolio. The analytical framework
underpinning the benchmark assesses the trade-off between the long-term
expected cost and risk of different portfolio structures, and provides
a basis for taking informed and consistent decisions about the nature
of Commonwealth market exposures. The benchmark is not implemented in
isolation but in conjunction with the sound management of other financial
risks including funding, liquidity, credit and operational risks, and
also has regard to the constraints imposed by broader public policy
considerations.

During 2000-01, the portfolio was maintained broadly within target
ranges during the first quarter of the year but, thereafter, a number
of other factors drove the portfolio parameters outside the benchmark
ranges. In responding to these factors the AOFM had particular regard
to the constraints imposed by public policy considerations, including
the market impact of potential transactions, in deciding to allow the
portfolio to remain outside the benchmark range. In particular, the
on balance judgement was that the risk associated with departing from
the benchmark range was acceptable when tested against the alternative
of a sharp increase in the size of the announced swap program.

The other key risk to be managed as part of portfolio management operations
is credit risk, the risk that a counterparty of the Commonwealth may
default on its obligations. In 2000-01, this risk continued to be managed
by reference to a comprehensive Swap Counterparty Credit Policy endorsed
by the Treasurer. The policy establishes minimum credit rating criteria
for acceptable counterparties and differential market and potential
exposure limits for various institutional counterparty types at different
rating points.

Legislative and administrative requirements

Debt issue, repurchase and redemption programs, including those related
to the redemption through the Debt Retirement Reserve Trust Account
of Commonwealth Government security debt on issue for the States and
Territories, were administered in accordance with the provisions of
the Commonwealth Inscribed Stock Act 1911, the Loans
Securities Act 1919, the Loans Redemption and Conversion Act
1921, the Financial Agreement Act 1994 and related legislation.

Debt assistance payments to the States and Territories, in the form
of Commonwealth sinking fund payments to the Debt Retirement Reserve
Trust Account (to assist them in their redemption of Commonwealth Government
securities on issue on their behalf) and untied grants (to compensate
them for the costs related to the cessation of Commonwealth borrowing
on their behalf), were made in accordance with the provisions of the
Financial Agreement Act 1994. All relevant accountability
requirements were met and enquiries from State and Territory Treasuries
concerning debt redemption matters were handled promptly.

Reporting on debt management

The 1999-2000 AOFM Annual Report was tabled in the Parliament on 31 October 2000.
The Report provided comprehensive information on CGS on issue and operations
in 1999-2000 in relation to that debt.

Financial performance - Agency items

As at 30 June 2001, the AOFM is in a strong financial position, reporting
positive net assets of $3.0 million, represented by $4.3 million of
assets and $1.3 million of liabilities.

In the context of the financial management reforms that have been implemented
by the Commonwealth government, the AOFM is cognisant of the need to
maintain cash reserves to fund the future settlement of employee liabilities,
make asset replacements and for future contingent events. Major commitments,
to date, in respect of $2.9 million cash holdings include:

- $1.1 million for employee leave entitlements owing as at 30 June
2001; and

- $0.6 million for asset replacements.

The AOFM has had a capital intensive period over the last twelve months
with expenditure on infrastructure, plant and equipment totalling approximately
$1.4 million, including an accommodation fit-out of $1.1 million.

The AOFM expects to undertake significant investment in new computer
hardware and software assets commencing in the 2001-02 financial year.
Capital appropriations have been made by Parliament for this purpose.

A recruitment program has commenced to increase staffing levels to
around 30 by end 2001, consistent with the AOFM's operational requirements.
Going forward, the financial management challenge for the AOFM will
be to manage its growth in a manner which guarantees the short-term
financial strength of the AOFM, while at the same time maintaining and
building upon reserves for future requirements.

Further information

The 2000-01 debt issuance and debt redemption programs and portfolio
management are considered in more detail in Parts 2 and 3 of this Report.
The Financial Statements for the AOFM are in Part 5.